Financial: S corporation or LLC? Think about it

November 12, 2013

Nov. 4/11 2013; Volume 27/number 14

By Bart Basi

Basi,-BartColor

Bart Basi

Today the choice of business structure is not so easy. Generally, the use of sole proprietorships and general partnerships is very limited to home-based businesses. Most businesspeople have the choice between operating as a limited liability company (LLC) or as an S corporation. When deciding which entity to operate under, the business owner must take a lot into consideration.

Ownership

With an LLC, there are no restrictions on ownership. An S corporation, on the other hand, does have restrictions. First, in order to hold S corporation status, a stockholder must be a resident and citizen of this country. Second, no more than 100 people are allowed to own the stock of an S corporation at any one time. If the ownership requirements are violated, the company will lose its S corporation status and will not be allowed to hold S corporation status for a number of years.

With an LLC, these restrictions do not exist and its status is not jeopardized. While most LLCs will maintain membership of well under 100 members, the option to expand the number of investors rapidly does exist. Many immigrants just starting a company can benefit from this form of business. A business owner operating as an LLC also has the advantage of looking to non-citizens as investors, thus increasing selling potential.

Formalities

There are fewer formalities in maintaining an LLC as opposed to an S corporation. This is a major convenience and aides in limiting liability; however, the LLC and S corporation are both potentially subject to being disregarded as an entity if the owner does not obey statutory formalities.

This usually happens when company owners do not observe formalities such as annual meetings, failure to elect officers, record meetings, keep paperwork and otherwise use the business as an “alter ego.”

The advantage here is that the LLC does not require as many statutory formalities as S corporations. Hence, the LLC can be a better insulator against liability if the occurrences of meetings and production of documents are going to be an issue.

Shares of an LLC are easier to put into a trust than an S corporation. To put shares of an S corporation into a trust, special language and provisions must be used, which can be complicated.

Taxes

During operation of an LLC, profits are taxed only at the shareholder level, the same as an S corporation. Profits from the operation of the business “flow through” to the income of the owner.  The income of the LLC is taxed to the owner. This can be a significant disadvantage if the LLC does not pay out distributions. Owners can find themselves facing large tax bills without the cash to cover it if the LLC has large profits, yet distributions are not made. Finally, owners of LLCs must select the type of tax return that is filed. No specific tax return exists for an LLC.

When winding up the affairs of the entity and dissolving, gains are taxed once. Nearly all businesses will eventually close their doors. Both the LLC and S corporation offer owners the chance to be taxed only once on the sale of the assets.

LLCs are becoming more popular because most business owners want a limit on liability, single layer taxation, no formalities and still enjoy the protections.

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